Corporations need money daily to finance their operating activities, embark on investment activities and pay taxes, interest expense, etc. corporations can raise capital in 2 ways:

**debt**and how much

**equity**should a company carry? We answer this question next:

**Capital Structure.**

**Weighted Average Cost of Capital (WACC)**is therefore an

**overall return**that a corporation MUST earn on its

**existing assets**and

**business operations**in order to increase or

**maintain the current value of the current stock**. For example, if Microsoft's WACC is 15% and current stock price is 28$, then the company must earn a 15% return on its existing assets and business operations (net income) in order to MAINTAIN the stock price at $28. The last thing that corporations would wish to happen is their stock price falling down!

**Weighted Average Cost of Capital (WACC)**

**[Rd x D/V x (1-T)] + [Re x E/V]**

**Rd**= Bond's yield to Maturity (I/Y in Calculator)

**D**= Market Value (Present Value) of Bonds

**(1 - T)**= 1 - tax rate = Interest tax shield deductibility of interest expense

**Re**= Shareholder's return requirement

**V**= Total value of all capital (Debt + Equity)

**Example**

Bond Calculations | Stock Calculations |

N = 3 x 2 = 6 I/Y = ? ( Rd)PV = 0.985 x 10,000 x $1000 = $9,850,000 ( D)PMT = (-10,000,000 x 0.06) / 2 = $-300,000 FV = $-10,000,000 P/Y = 2 C/Y = 2 Solution: I/Y = 6.56% | Re = Rf + B[Rm - Rf] Re = 0.045 + 1.5 [0.145 - 0.045] Re = 0.045 + 0.15 = 0.195 (19.5%)Market Value of Equity = Stock price x common shares outstanding $10 x 2,000,000 = $20,000,000 |

**V = Total Capital Structure**

**WACC = [Rd x D/V x (1-5)] + [Re x E/V]**

**0.1458 -> 14.58%****Interpretation of WACC**

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